From the gas pump to the grocery store to our morning coffee, consumers are getting squeezed by forces we can’t control – or, it seems, even understand.
Commodities such as oil , gold , copper and agricultural products have been experiencing drastic price swings over the past few years, and that affects our most basic needs, from heating homes to manufacturing and transporting food and clothing.
As an example, oil peaked at $147 (U.S.) a barrel in June, 2008, and plunged to $30 before the year was out. It rose and fell again, and made its way back up to a $115 high in May this year, before plunging to $80 by late September. Gold skyrocketed from less than $600 an ounce five years ago to $1,900 in early September this year, before falling back down to $1,630 in late September.
Much of the blame has been directed at speculators looking to make a quick buck. According to investment bank Barclays Capital, more than $200-billion has been pumped into commodities since 2006 – nearly doubling the total $431-billion currently under management.
Bart Chilton, a commissioner with the U.S. Commodity Futures Trading Commission, delivered a speech to the United Nations in New York recently supporting the market regulator’s effort to reduce volatility by creating tighter rules on trading. One idea is to impose “position limits” to strike a better balance between fundamental supply and demand trading, where traders actually sell and take delivery of physical commodities when contracts expire, and complex hedge strategies, where commodity-related derivatives are traded throughout the life of the contract.
The recommendation comes on the heels of political pressure from Washington that resulted in a rare two-day CFTC hearing last August, aimed at pinpointing where fundamentals end and speculation begins when it comes to determining the price of commodities. Past studies by regulatory agencies and academics have failed to establish a relationship between speculation and volatility in the commodities market.
One submission included a study from Stanford University professor Kenneth Singleton that delves into the 2008 oil boom and bust. He concludes that what may seem like speculation is actually fundamental influences we don’t yet understand. “People are groping for information about fundamentals and we have imperfect information,” he says. “Fundamentals are at the heart of [why]we might see periods of enhanced volatility.”
He says the introduction of more market participants, such as exchange traded, hedge, pension and mutual funds, create more momentum and more volatility – and record low interest rates help fuel the market further.
He suggests regulators such as the CFTC should focus less on trading restrictions and more on extracting better supply and demand information from producing countries and industry groups such as OPEC and the Organization for Economic Co-operation and Development (OECD).
Major commodity exchanges, including the CME Group – owner of the Chicago Mercantile Exchange (CME) and the New York Mercantile Exchange (NYMEX) – generally oppose restrictions that could stand in the way of trade, or fat commissions for traders.
Regardless, veteran front-line floor traders have taken note of the increased volatility and admit they’ve witnessed the effect of an explosion in the number of players in the commodity game.
“There are a lot of traders in these markets who are not users, producers or part of the industry,” says Anthony Grisanti, NYMEX oil and natural gas trader and president of GRZ Energy. Despite the recent drop in the price of oil, he says, speculators are still driving the price of crude up by as much as $10 a barrel above what he considers fundamentals.
“With the global economy the way it is, oil shouldn’t be trading at this level, and it’s probably going higher,” he says.
Much of the demand for commodities is coming from developing nations in Asia, Latin America and Eastern Europe, but a lot of the inflows come from investors looking for a safe haven in a world of economic turmoil. Mr. Grisanti says the problem is compounded by the U.S. Federal Reserve Board policy of attempting to stimulate the sluggish economy by keeping the official benchmark interest rate near zero. “If [the Fed]continues to keep going with that policy, you’re going to see a lot more cheap money fly into these markets.”
From the floor of the CME, Joe Kinahan, chief derivatives strategist with TD Ameritrade, agrees with Mr. Grisanti. He sees a lot of super-fuelled speculative trading activity in metals, agriculture and energy. “There’s tons of liquidity in the market. People feel like they understand the product whether they truly understand it or not.”
Mr. Kinahan’s litmus test for determining whether a market is rife with speculators is what he calls “the cocktail party test.”
“When you’re at a cocktail party and people who aren’t traders are talking about the commodity, it’s the sexy product of trade. That’s what oil was a year ago; that’s what gold is now,” he explains.
He compares the recent rise in gold prices to the technology bubble of the late 1990s, when investors were sinking billions into dot-com companies with far-off visions of earnings or even revenue. A more recent comparison is the real estate bubble less than five years ago.
Does that mean he believes gold is trading in a bubble? “I don’t want to use the word bubble, but as a trader I avoid being long gold,” he says.
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